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1 The Firecracker Report
We invite you to visit our new blog at The Firecracker Report.  Gold Stocks Lagging Gold Prices - Traditional Correlations Breaking Down
Since September, some interesting dynamics have been unfolding in the gold market. Whilephysical gold prices have soared to new highs, gold stocks have not followed through.
Figure 1: Goldcorp (Ticker: GG) stock price versus the price of Gold/oz (bluearrows).
The Chart above maps out the stock price of Goldcorp (GG) versus prices of physical gold.As we can see, even though Gold made new highs in October and November, Goldcorp
‟ 
sstock price did not breach its Sept high of 42.91. Now we have used Goldcorp here as anexample but the above dynamics are true for virtually all gold miner stocks.In addition, an examination of monthly correlations between Goldcorp
‟ 
s stock and 3variables: the S&P 500, underlying physical gold prices and EUR/USD exchange raterespectively, throws up some interesting trends. (Note that these Goldcorp correlationdynamics will extend to all mining stocks).
$1097$1061$1032$1062$1058$1004$1014$1016$989
 
$933$961$952$931$912GG Peak stockprice $42.91
 
 
2 The Firecracker ReportAs shown in Figure 2, in July 2009 Goldcorp stock moved in strong correlation with all 3variables. However, off late (Oct-Nov) its correlation with underlying physical gold and theUSD exchange rates have broken down. Instead Goldcorp prices appear to be now highlycorrelated with only 1 variable the S&P 500.
Monthly CorrelationsGG Stock and S&P 500 GG Stock & Physical Gold GG Stock & EUR/USD FX RateOct-Nov 2009
69% 35% -24%
Sept 2009
40% 66% -25%
Aug 2009
15% 87% -79%
July 2009 85% 95% -92%June 2009
69% 80% -69%
May 2009
6% 95% -93%
Figure 2: Monthly correlations between Goldcorp stock and 3 variables: S&P 500,physical gold and USDEUR exchange rate.
Interestingly in May 2009 the reverse held true, with Goldcorp stock exhibiting strongcorrelation with the EUR/USD FX rate and physical gold prices and almost no correlationwith the S&P 500.
So how come Gold stocks have delinked from underlying gold prices and becomestrongly correlated with the S&P?
There are a couple of explanations:1.
 
The gold miner stocks are in cautious territory. The stocks appear to be pausing,unsure whether physical gold prices will hold their current levels of ~$1100. Oncecurrent levels have been firmly established gold miner stocks will move up to followgold higher, if not then miner stocks will correct.2.
 
In addition, there is caution in the market regarding a potential dollar rally and asubsequent correction in the S&P. Given that the Fed has ended its quantitativeeasing (QE) in US Treasuries, this removes some support from equity markets in theform of POMO induced equity purchases (dealers leveraging QE money to buystocks). Equity and commodity markets could therefore correct downwards and thedollar could rally a little bit. And although miner stocks have currently decoupledfrom the dollar, in the event of a dollar rally, their historical strong negativecorrelation could once again reappear.3.
 
As highlighted recently by Professor Roubini, any event that causes an unwinding of the dollar carry trade could result in a huge short covering rally in the US dollar andsubsequent correction in the equity and physical gold markets. Given that the Fedneeds to raise ~$2 trillion in new treasuries this fiscal year, this event is not out of question (see conclusion below for further explanation).
 
 
3 The Firecracker Report4.
 
In a Bloomberg article,John Roque, managing director in technical analysis at WJB in New York offers another explanation. According to him,
 “
Gold may outperformmining stocks to a greater degree than it did in the past because the creation of exchange-
traded funds is allowing investors to wager directly on the metal‟s price
without needing to buy mining stocks
” 
. (This explanation is somewhat applicable butdoes not explain the full picture.)
Conclusion
Overall the caution in gold miner stocks is justified. Although we strongly believe that goldwill move much higher than the current $1100 level over the long term, however in theshort term the picture could play out differently. The Fed is currently caught between a rockand a hard place. On one hand it has announced a pause in its buybacks of US Treasuries,while on the other hand it needs to borrow ~$2 trillion more by issuing new treasuries tofund the budget deficits for 2010. Given that foreign central banks are keen to diversifyaway from the dollar (as evidenced by the recent purchase of gold by India), we worryabout the Fed being able to fulfill their borrowing needs and still keep interest rates low.Therefore we would err on the side of exercising great caution while going long the stockmarket. The Fed may be forced to
 “
induce
” 
a flight from risky assets such as stocks andcommodities, into
 “
safe
” 
assets like Treasuries in order to keep the long end of the interestrate curve under control.The next few months are critical, and investors would do well to proceed with great caution.
About the Firecracker Report
 
The Firecracker Report is a financial and geopolitical analysis blog started by a team of ex-
 
Wall Streeter‟s with extensive banking and investing experience. We strongly feel that in the
current era of corporatized propaganda driven
news the „real‟ news often goes unreported.
We have therefore chosen to lend our voices and join the growing ranks of independentbloggers that aim to bring insightful commentary and analysis to their readers.We invite you to visit our blog and would love to hear your thoughts and comments. We can
 
be reached at firecracker.report@gmail.com 
Global Disclaimer
The contents and data of The Firecracker Report are published solely for general information purposes only and do not constitutefinancial recommendation or advice. The content of this report is not to be construed as a solicitation or an offer to buy or sell anysecurities or related financial instruments in any jurisdiction. The author(s) of the Firecracker Report are not licensed investmentadvisors. Thus, the Firecracker Report does not give investment advice and does not advocate the purchase or sale of any securityor investment by you or any other individual. It is understood that investment decisions carry risk and are the responsibility of individuals and their professionally licensed investment advisors. Investors should exercise prudence in making their investment
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